The Case for Maintaining CAD Exposure Amid Sticky Canadian Inflation and Rate Stability

In the intricate dance of global markets, the Canadian dollar (CAD) has long been a barometer of both domestic resilience and international uncertainty. As of August 2025, the loonie finds itself at a crossroads, shaped by the Bank of Canada's (BoC) measured policy approach, persistent inflationary pressures, and the lingering shadows of U.S. trade tensions. For investors, this environment presents a nuanced opportunity: a case for maintaining CAD exposure hinges on the interplay of central bank credibility, inflation resilience, and the currency's undervaluation relative to its long-term fundamentals.

Central Bank Policy: A Cautious Balancing Act

The BoC's forward guidance has crystallized into a framework of patience and adaptability. With the policy rate held steady at 2.75% since July 2025, the central bank has signaled a preference for data-dependent decisions, resisting the urge to overreact to short-term volatility. This approach reflects a recognition of the lagged effects of monetary policy and the need to avoid premature easing, which could reignite inflationary pressures. The BoC's latest Monetary Policy Report underscores a balanced view: while headline inflation has moderated to 1.9% year-over-year, core measures like CPI-trim and CPI-median remain stubbornly near 3%, hovering at the upper edge of the 1%-3% target range.

This duality—stable headline inflation masking persistent core inflation—has positioned the BoC as a disciplined actor. By avoiding aggressive rate cuts, the central bank has preserved its credibility in managing inflation expectations. For CAD, this stability is a double-edged sword. On one hand, the absence of rate hikes reduces immediate upward pressure on the currency. On the other, the BoC's readiness to cut rates in response to a weakening labor market or trade shocks introduces downside risks. Yet, the BoC's emphasis on inflation resilience—supported by its success in curbing headline inflation to near target—suggests that any rate cuts will be gradual and conditional, limiting the magnitude of CAD depreciation.

Inflation Resilience: A Shield Against Depreciation

The BoC's ability to anchor inflation expectations has been a critical underpinning for CAD. Despite the imposition of U.S. tariffs on Canadian goods and the associated trade uncertainties, inflation has not spiked as feared. The removal of the consumer carbon levy and falling gasoline prices have cushioned headline inflation, while core inflation remains elevated due to domestic service price pressures and retaliatory tariffs on food and vehicles. This dynamic has created a unique scenario: Canadian consumers are experiencing a mix of relief and restraint, with spending on essentials and discretionary services (e.g., dining, entertainment) remaining robust.

The resilience of consumer spending is a testament to the Canadian economy's adaptability. The RBC Consumer Spending Tracker reveals that while retail sales contracted in June 2025, quarterly growth in categories like dining and entertainment has remained positive. Consumers are also shifting toward domestic goods and services, with over 60% planning to increase spending on Canadian-made products. This behavioral shift, driven by patriotism and economic self-interest, has insulated the economy from a sharper downturn. For CAD, this means that the currency's weakness is not rooted in a collapse of domestic demand but in external factors—U.S. trade policy and interest rate differentials—that are likely to normalize over time.

Currency Valuation Dynamics: A Case for Strategic FX Positioning

The CAD's depreciation against the U.S. dollar—trading in the 1.36–1.38 range as of August 2025—has been driven by a combination of factors. The most immediate is the widening interest rate differential between Canada and the U.S., with the BoC's 2.75% rate trailing the Fed's 3.75% by over 100 basis points. However, the CAD's underperformance is also influenced by risk premiums tied to U.S. trade policy. Investors are pricing in a higher probability of further tariffs, which has increased demand for hedging instruments and pushed the CAD lower.

Yet, this depreciation may represent a mispricing. Historical patterns suggest that prolonged interest rate differentials are often offset by future currency appreciation, particularly when the fundamentals of the weaker economy (in this case, Canada) remain intact. The BoC's success in stabilizing inflation, coupled with the U.S. Federal Reserve's potential to ease rates in 2026, could narrow the differential and trigger a CAD rebound. Moreover, the Canadian dollar's sensitivity to commodity prices—particularly oil—adds another layer of opportunity. If global energy markets stabilize, the CAD could benefit from a tailwind that is currently underappreciated by markets.

The Investment Case: Timing the Rebound

For investors, the case for CAD exposure rests on three pillars:
1. Policy Credibility: The BoC's measured approach to rate cuts and its focus on inflation resilience provide a floor for the currency.
2. Undervaluation: The CAD's current weakness is driven by external risks (e.g., U.S. tariffs) rather than domestic economic fundamentals, making it a candidate for a rebound as trade tensions ease.
3. Asymmetric Payoff: A potential normalization of U.S. trade policy and Fed easing could unlock significant upside for the CAD, while downside risks are limited by the BoC's readiness to act.

Strategic FX positioning now involves hedging against short-term volatility while capitalizing on the long-term case for CAD appreciation. Investors might consider dollar-cost averaging into CAD positions or using options to lock in entry points. Additionally, sectors tied to the Canadian economy—such as energy and consumer discretionary—could benefit from a stronger CAD, offering a dual play on currency and equity performance.

In conclusion, the Canadian dollar's near-term challenges are not a reflection of its long-term potential. The BoC's disciplined policy, the economy's inflation resilience, and the currency's undervaluation create a compelling case for maintaining CAD exposure. For investors with a medium-term horizon, the loonie represents a strategic opportunity to capitalize on the interplay of policy, inflation, and global trade dynamics—a reminder that markets often overcorrect, and patience is rewarded.